This document discusses accounting for merchandising operations under a perpetual inventory system. It covers recording purchases and sales, including returns and discounts. It explains adjusting entries needed to update inventory balances and the multiple-step income statement format that distinguishes gross profit and operating expenses. The accounting cycle for a merchandising company is similar to a service company except for an additional inventory adjustment entry.

1. 5-1
5
Learning Objectives
After studying this chapter, you should be able to:
[1] Identify the differences between a service and merchandising companies.
[2] Explain the recording of purchases under a perpetual inventory system.
[3] Explain the recording of sales revenues under a perpetual inventory
system.
[4] Explain the steps in the accounting cycle for a merchandising company.
[5] Distinguish between a multiple-step and a single-step income statement.
Accounting for
Merchandising Operations

2. 5-2 LO 1 Identify the differences between service and merchandising companies.
Merchandising Companies
Buy and Sell Goods
Wholesaler Consumer
The primary source of revenues is referred to as
sales revenue or sales.
Retailer
Merchandising Operations

3. 5-3 LO 1 Identify the differences between service and merchandising companies.
Income Measurement
Cost of goods sold is the total
cost of merchandise sold during
the period.
Not used in a
Service business.
Net
Income
(Loss)
Less
Less
Equals
Equals
Sales
Revenue
Cost of
Goods Sold
Gross
Profit
Operating
Expenses
Illustration 5-1
Income measurement process for a
merchandising company
Merchandising Operations

4. 5-4
The operating
cycle of a
merchandising
company
ordinarily is longer
than that of a
service
company.
Illustration 5-2
LO 1 Identify the differences between service and merchandising companies.
Operating
Cycles
Merchandising Operations
Illustration 5-3

5. 5-5
Flow of Costs
Companies use either a perpetual inventory system or a periodic inventory
system to account for inventory.
LO 1 Identify the differences between service and merchandising companies.
Illustration 5-4
Merchandising Operations

6. 5-6
Perpetual System
LO 1 Identify the differences between service and merchandising companies.
 Maintain detailed records of the cost of each inventory
purchase and sale.
 Records continuously show inventory that should be on
hand for every item.
 Company determines cost of goods sold each time a
sale occurs.
Flow of Costs
Merchandising Operations

7. 5-7
 Do not keep detailed records of the goods on hand.
 Cost of goods sold determined by count at the end of
the accounting period.
 Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
LO 1
Merchandising Operations
Periodic System
Flow of Costs

8. 5-8
 Traditionally used for merchandise with high unit values.
 Shows the quantity and cost of the inventory that should
be on hand at any time.
 Provides better control over inventories than a periodic
system.
LO 1 Identify the differences between service and merchandising companies.
Flow of Costs
Advantages of the Perpetual System
Merchandising Operations

9. 5-9
 Made using cash or credit (on account).
LO 2 Explain the recording of purchases under a perpetual inventory system.
 Normally record when
goods are received from the
seller.
 Purchase invoice should
support each credit
purchase.
Illustration 5-6
Recording Purchases of Merchandise

10. 5-10
Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply,
Inc. (the seller). Prepare the
journal entry for Sauk Stereo for
the invoice from PW Audio
Supply.
Inventory 3,800
May 4
Accounts Payable 3,800
LO 2 Explain the recording of purchases under a perpetual inventory system.
Illustration 5-6
Recording Purchases of Merchandise

11. 5-11
Illustration 5-7
Shipping terms
Ownership of the goods
passes to the buyer when the
public carrier accepts the
goods from the seller.
Ownership of the goods
remains with the seller until
the goods reach the buyer.
Freight Costs – Terms of Sale
Freight costs incurred by the seller are an operating expense. LO 2
Recording Purchases of Merchandise

12. 5-12
Illustration: Assume upon delivery of the goods on May 6,
Sauk Stereo pays Public Freight Company $150 for freight
charges, the entry on Sauk Stereo’s books is:
Inventory 150
May 6
Cash 150
LO 2 Explain the recording of purchases under a perpetual inventory system.
Assume the freight terms on the invoice in Illustration 5-6 had
required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would have been:
Freight-Out 150
May 4
Cash 150
Recording Purchases of Merchandise

13. 5-13
Purchaser may be dissatisfied because goods are damaged
or defective, of inferior quality, or do not meet specifications.
Purchase Returns and Allowances
Return goods for credit if the
sale was made on credit, or
for a cash refund if the
purchase was for cash.
May choose to keep the
merchandise if the seller will
grant a reduction of the
purchase price.
Purchase Return Purchase Allowance
LO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise

14. 5-14 LO 2 Explain the recording of purchases under a perpetual inventory system.
Illustration: Assume Sauk Stereo returned goods costing
$300 to PW Audio Supply on May 8.
Accounts Payable 300
May 8
Inventory 300
Recording Purchases of Merchandise

15. 5-15
In a perpetual inventory system, a return of defective
merchandise by a purchaser is recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Inventory
LO 2 Explain the recording of purchases under a perpetual inventory system.
Review Question
Recording Purchases of Merchandise

16. 5-16
Credit terms may permit buyer to claim a cash discount
for prompt payment.
Advantages:
 Purchaser saves money.
 Seller shortens the operating cycle by converting the
accounts receivable into cash earlier.
Purchase Discounts
Example: Credit terms
may read 2/10, n/30.
LO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise

17. 5-17
2% discount if
paid within 10
days, otherwise
net amount due
within 30 days.
1% discount if
paid within first 10
days of next
month.
2/10, n/30 1/10 EOM
Net amount due
within the first 10
days of the next
month.
n/10 EOM
LO 2 Explain the recording of purchases under a perpetual inventory system.
Purchase Discounts - Terms
Recording Purchases of Merchandise

18. 5-18
Accounts Payable 3,500
May 14
Cash 3,430
Inventory 70
(Discount = $3,500 x 2% = $70)
LO 2 Explain the recording of purchases under a perpetual inventory system.
Illustration: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo
makes on May 14 to record the payment.
Recording Purchases of Merchandise

19. 5-19
Accounts Payable 3,500
June 3
Cash 3,500
LO 2 Explain the recording of purchases under a perpetual inventory system.
Illustration: If Sauk Stereo failed to take the discount, and
instead made full payment of $3,500 on June 3, the journal
entry would be:
Recording Purchases of Merchandise

20. 5-20
Should discounts be taken when offered?
Purchase Discounts
Discount of 2% on $3,500 70.00
$
$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount 50.82
$
Example: 2% for 20 days = Annual rate of 36.5%
$3,500 x 36.5% x 20 ÷ 365 = $70
LO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise

21. 5-21
Inventory
Debit Credit
3,800 8th - Return
300
Balance
4th - Purchase
3,580
70 14th - Discount
Summary of Purchasing Transactions
150
6th – Freight-in
LO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise

22. 5-22
 Made using cash or credit (on account).
 Sales revenue, like service
revenue, is recorded when
the performance obligation
is satisfied.
 Performance obligation is
satisfied when the goods
are transferred from the
seller to the buyer.
 Sales invoice should
support each credit sale.
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Illustration 5-6
Recording Sales of Merchandise

23. 5-23
Journal Entries to Record a Sale
Cash or Accounts receivable XXX
Sales revenue XXX
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
#1
Cost of goods sold XXX
Inventory XXX
#2
Selling
Price
Cost
Recording Sales of Merchandise

24. 5-24
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Accounts Receivable 3,800
May 4
Sales Revenue 3,800
Illustration: PW Audio Supply records the sale of $3,800
on May 4 to Sauk Stereo on account (Illustration 5-6) as
follows (assume the merchandise cost PW Audio Supply
$2,400).
Cost of Goods Sold 2,400
4
Inventory 2,400
Recording Sales of Merchandise

25. 5-25 Advance slide in presentation mode to reveal answer.

26. 5-26
 “Flip side” of purchase returns and allowances.
 Contra-revenue account to Sales Revenue (debit).
 Sales not reduced (debited) because:
► Would obscure importance of sales returns and
allowances as a percentage of sales.
► Could distort comparisons.
Sales Returns and Allowances
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise

27. 5-27
Illustration: Prepare the entry PW Audio Supply would make
to record the credit for returned goods that had a $300 selling
price (assume a $140 cost). Assume the goods were not
defective.
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Sales Returns and Allowances 300
May 8
Accounts Receivable 300
Inventory 140
8
Cost of Goods Sold 140
Recording Sales of Merchandise

28. 5-28
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Sales Returns and Allowances 300
Accounts Receivable 300
Inventory 50
Cost of Goods Sold 50
Illustration: Assume the returned goods were defective
and had a scrap value of $50, PW Audio would make the
following entries:
May 8
8
Recording Sales of Merchandise

29. 5-29
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
The cost of goods sold is determined and recorded each
time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory system.
Review Question
Recording Sales of Merchandise

30. 5-30
 Offered to customers to promote prompt payment of the
balance due.
 Contra-revenue account (debit) to Sales Revenue.
Sales Discount
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise

31. 5-31
LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Cash 3,430
May 14
Accounts Receivable 3,500
Sales Discounts 70
* [($3,800 – $300) X 2%]
*
Illustration: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.
Recording Sales of Merchandise

32. 5-32
 Generally the same as a service company.
 One additional adjustment to make the records agree with
the actual inventory on hand.
 Involves adjusting Inventory and Cost of Goods Sold.
LO 4 Explain the steps in the accounting cycle for a merchandising company.
Completing the Accounting Cycle
Adjusting Entries

33. 5-33 LO 4 Explain the steps in the accounting cycle for a merchandising company.
Illustration: Suppose that PW Audio Supply has an unadjusted
balance of $40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is $40,000. The company would make an adjusting
entry as follows.
Cost of Goods Sold 500
Inventory 500
Completing the Accounting Cycle

34. 5-34
Completing the Accounting Cycle
Closing
Entries
LO 4 Explain the steps in the accounting cycle for a merchandising company.

35. 5-35
Completing the Accounting Cycle
Closing Entries
LO 4 Explain the steps in the accounting cycle for a merchandising company.

36. 5-36
Multiple-Step Income Statement
Forms of Financial Statements
 Shows several steps in determining net income.
 Two steps relate to principal operating activities.
 Distinguishes between operating and non-operating
activities.
LO 5 Distinguish between a multiple-step and a single-step income statement.

37. 5-37
Multiple-
Step
Illustration 5-14
LO 5
Key Items:
 Net sales
Illustration 5-14

38. 5-38
Illustration 5-14
LO 5
Multiple-
Step
Illustration 5-14
Key Items:
 Net sales
 Gross profit

39. 5-39
Key Items:
 Net sales
 Gross profit
 Operating
expenses
LO 5
Multiple-
Step
Illustration 5-14
Illustration 5-14

40. 5-40
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities
LO 5
Multiple-
Step
Illustration 5-14

41. 5-41
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities
LO 5
Multiple-
Step
Illustration 5-14

42. 5-42
Multiple-
Step
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Nonoperating
activities
 Net income
LO 5
Illustration 5-14

43. 5-43
The multiple-step income statement for a merchandiser
shows each of the following features except:
a. gross profit.
b. cost of goods sold.
c. a sales revenue section.
d. investing activities section.
Review Question
Forms of Financial Statements
LO 5 Distinguish between a multiple-step and a single-step income statement.

44. 5-44
 Subtract total expenses from total revenues
 Two reasons for using the single-step format:
1. Company does not realize any profit until total
revenues exceed total expenses.
2. Format is simpler and easier to read.
Single-Step Income Statement
Forms of Financial Statements
LO 5 Distinguish between a multiple-step and a single-step income statement.

45. 5-45
Illustration 5-15
Single-Step Income Statement
Forms of Financial Statements
LO 5 Distinguish between a multiple-step and a single-step income statement.

46. 5-46
Illustration 5-16
Classified Balance Sheet
Forms of Financial Statements
LO 5 Distinguish between a multiple-step and a single-step income statement.

47. 5-47
 No running account of changes in inventory.
 Ending inventory determined by physical count.
 Cost of goods sold not determined until the end of the
period.
Determining Cost of Goods Sold Under a
Periodic System
APPENDIX 5B Periodic Inventory System
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.

48. 5-48
Determining Cost of Goods Sold Under a
Periodic System
LO 7
Illustration 5B-2
APPENDIX 5B Periodic Inventory System

49. 5-49
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Record revenues when sales are made.
 Do not record cost of merchandise sold on the date of sale.
 Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.
 Record purchases in Purchases account.
 Purchase returns and allowances, Purchase discounts, and
Freight costs are recorded in separate accounts.
Recording Merchandise Transactions
APPENDIX 5B Periodic Inventory System

50. 5-50
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Illustration: On the basis of the sales invoice (Illustration 5-6)
and receipt of the merchandise ordered from PW Audio Supply,
Sauk Stereo records the $3,800 purchase as follows.
Purchases 3,800
May 4
Accounts Payable 3,800
Recording Purchases of Merchandise
APPENDIX 5B Periodic Inventory System

51. 5-51
Illustration: If Sauk pays Public Freight Company $150
for freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk’s books is:
Freight-in (Transportation-In) 150
May 6
Cash 150
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Freight Costs
APPENDIX 5B Periodic Inventory System

52. 5-52
Accounts payable 300
May 8
Purchase Returns and Allowances 300
Purchase Returns and Allowances
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Illustration: Sauk Stereo returns $300 of goods to PW Audio
Supply and prepares the following entry to recognize the
return.
APPENDIX 5B Periodic Inventory System

53. 5-53
Accounts Payable 3,500
May 14
Purchase Discounts 70
Purchase Discounts
Cash 3,430
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Illustration: On May 14 Sauk Stereo pays the balance due
on account to PW Audio Supply, taking the 2% cash discount
allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.
APPENDIX 5B Periodic Inventory System

54. 5-54
No entry is recorded for cost of goods sold at the time of the
sale under a periodic system.
Illustration: PW Audio Supply, records the sale of $3,800 of
merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
Illustration 5-6) as follows.
Accounts Receivable 3,800
May 4
Sales Revenue 3,800
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Recording Sales of Merchandise
APPENDIX 5B Periodic Inventory System

55. 5-55
Illustration: To record the returned goods received from Sauk
Stereo on May 8, PW Audio Supply records the $300 sales
return as follows.
Sales Returns and Allowances 300
May 8
Accounts Receivable 300
Sales Returns and Allowances
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
APPENDIX 5B Periodic Inventory System

56. 5-56
Cash 3,430
May 14
Accounts Receivable 3,500
Sales Discounts 70
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Sales Discounts
Illustration: On May 14, PW Audio Supply receives payment
of $3,430 on account from Sauk Stereo. PW Audio honors the
2% cash discount and records the payment of Sauk’s account
receivable in full as follows.
APPENDIX 5B Periodic Inventory System

57. 5-57
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Comparison of Entries
APPENDIX 5B Periodic Inventory System
Illustration 5B-3

58. 5-58
LO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Comparison of Entries
APPENDIX 5B Periodic Inventory System
Illustration 5B-3